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4 Reasons the U.S. Dollar Is Here to Stay

Published 04/19/2023, 12:07 PM
Updated 07/09/2023, 06:31 AM
  • The dollar will be extremely hard to replace for four reasons: The rule of law, liquid financial markets, and economic and military might.
  • 60% of global currency reserves are in dollars, and about 90% of trade occurs in dollars.
  • No other currency or block of nation’s currencies, gold-backed currency, or bitcoin is currently a viable candidate to replace the dollar as the global reserve currency.

The media once again presumes that America’s financial negligence will result in a new global reserve currency. As written earlier,

 “Don’t hold your breath. Headlines forecasting the dollar’s death as the world’s reserve currency have been around for a long time.”

While the case for a new global reserve currency is strong, the replacement options pale in comparison. There are four important reasons why finding a replacement will prove difficult.

The four reasons, the rule of law, liquid financial markets, and economic and military, might guarantee that the death of the US dollar will not occur anytime soon.

The earlier article provides background for the dollar’s role as the global reserve currency and the inherent flaws in serving that role. The construct of the dollar and the reasons for its birth as the world’s currency is an essential foundation for understanding its current position.

1. The Rule of Law

The rule of law helps ensure that US citizens and institutions are provided human rights, property, contracts, and procedural rights. While many other nations may claim to have similar legal processes, few live up to US standards. The legal system equally protects foreigners with dollars and other financial and legal interests in the US.

From a currency perspective, the court system, not a government decree, rules on financial disputes. It is undoubtedly flawed and biased. As Russia, Iran, and other countries have found, the US government will seize their dollars if they deem it in its best interest. While such acts bend the value of the rule of law, almost all foreign nations are confident that the US system of law and governance ensures their ability to hold and transact in US dollars. Further, laws and regulations provide confidence in the proper functioning of US markets they rely heavily on to meet their borrowing and investment needs.

Hedge fund mogul Mark Mobius is discovering why investing in countries less judicious than the US can be dangerous. Per CNN, Mobius, founder of Mobius Capital Partners, told FOX Business on March 2, 2023, 

I have an account with HSBC in Shanghai. I can’t take my money out. The government is restricting the flow of money out of the country,” 

For those thinking that China, Russia, and Saudi Arabia can cobble together a reserve currency, ask yourself a question. If you were the leader of a nation, would you leave funds in their banking system or trust their government with said funds? More importantly, do you even think those countries trust each other?

2. Liquid Markets

From an operational perspective, the size and liquidity of US financial markets and the ease with which foreigners can borrow and invest US dollars are of utmost importance.

Foreigners enacting global trade need dollars to facilitate exchange. Therefore, they hold dollars and maintain the ability to borrow dollars. International trade requires a financial system with immense liquidity. Further, the more liquid a market, the lower the borrowing, investing, and hedging costs.

In this respect, the US is second to none. The US bond markets are considered the world’s deepest and most liquid markets. As we quote below, the US bond market accounts for almost 40% of all bonds outstanding globally.

Per the Securities Industry and Financial Markets Association (SIFMA):

As of 2021, the size of the bond market (total debt outstanding) is estimated to be at $119 trillion worldwide and $46 trillion for the U.S. market.”

3. Military Might

A key factor allowing Europe and Japan to recover quickly from World War II was the ability to borrow US dollars and use the money to focus on rebuilding. Equally important, they did not have to refortify their military for another war. America had its back if another country were to invade. As a result, over 750 US military bases currently exist in more than 80 countries.

Let’s consider Ukraine’s situation. Its defense against Russia is being heavily funded and supported by the US. What might happen if Ukraine starts trading with Chinese yuan or euros? Do you think America would still give them the support they desperately need? Does Ukraine have the ability to forgo using the dollar in trade? The answer to both questions is a definitive no.

The graph below shows the US Accounts for about 80% of military aid to Ukraine.

Military Aid to Ukraine

With China and Russia flexing their military muscles, other countries are watching the situation and recognizing that the dollar and America’s military are a package deal.

Given America’s superpower status, for another currency to become the global reserve currency, accepted by an overwhelmingly large percentage of countries, that replacement government will have to defeat the US.

Countries With Highest Military Expenditure

4. Economic Power

As shown below, the United States economy is roughly the same size as the next three largest economies combined. Given U.S. economic activity dwarfs every nation but China, a large percentage of global trade involves U.S.-based buyers and sellers. The dollar is the preferred currency to facilitate exchange with these entities.

15 Largest Economies by GDP

Current Dollar Status

According to the IMF, the dollar makes up almost 60% of global foreign exchange reserves. While the percentage has declined by about 10% over the last decade, it is still three times the next leading reserve, the euro, which accounts for about 20% of global reserves. For those concerned about China, their currency, the renminbi (yuan), accounts for 2.5% of all reserves. That is reason enough to count China out.

Per the BIS, foreign dollar-denominated debt totals approximately $16 trillion. That is up from $10 trillion in 2008. Next in line is foreign euro-denominated debt at roughly $4 trillion. That amount has not changed since 2008.

Data from the BIS and the graph below from @donnelly_brent show the dollar accounts for almost 90% of global transactions. That percentage has been steady over the last thirty years.

Transactions By Currency

Summary

The pundits will be right someday. The dollar’s death as the reserve currency will come, and some other nation’s currency, cryptocurrency, gold, shells, or something else will take its place. However, that day is not coming anytime soon. The four reasons in the article leave the world with no alternative.

While China is rapidly growing its economy and global trade footprint, it lacks the rule of law and liquid capital markets to sustain a global currency. It’s difficult to see how a communist country can overcome those challenges.

The euro is the most viable competitor. They have the rule of law, but their capital markets are not nearly liquid enough to facilitate global trade. They also lack the military might to force the usage of the euro. Let us also remember its finances are in equally bad or even worse shape than the US. There is no reason to suspect the euro could overtake the dollar.

Bitcoin? Forget about it! The government will never relinquish its control over the currency because, with that, they lose control of the nation.

Gold-backed dollars were a mainstay until 1971. However, as we have learned for the last fifty years, gold restricts the ability of the central bank to run monetary policy as they see fit. A rules-based system, like gold-backed dollars, might benefit the economy. However, regardless of your thoughts, the Fed and government are not the ones to give up power.

Latest comments

The U.S. dollar first emerged as an important international reserve currency in the 1920s, displacing the British pound sterling as it emerged from the First World War relatively unscathed and since the United States was a significant recipient of wartime gold inflows. After the United States emerged as an even stronger global superpower during the Second World War, the Bretton Woods Agreement of 1944 established the U.S. dollar as the world's primary reserve currency and the only post-war currency linked to gold. Despite all links to gold being severed in 1971, the dollar continues to be the world's foremost reserve currency for international trade to this day. Source: Wikipedia
There's only 1 reason and all other derive from it. US military might... and anyone with understanding how freedom and free trade works will cheer that US is militarily the top dog. Even with faults of US system and policies, the next "best thing" is what? China's communism? No thanks, I had enough of that in past.
If you think the US military is strong, after Biden's flunkies drummed the best of the best out of our armed forces through Covid mandate refusals, and Biden leaving BILLIONS worth of our best military equipment behind in Afghanistan, you are woefully mistaken. Besides, Biden and most of his administration is bought and paid for by the CCP anyway. If they wanted to, China could land troops on our shores, and this 'President' wouldn't lift a finger to stop it.
  I'm not saying Sleepy Joe did a good job. Still even after those blunders, US is only country with military that continuously successfully wages war. Yes, results are often lost thanks to politics, but US arsenal and men continuously prove their worth. You can't say that for China military. Russia, we don't need to comment, unless it's their nuclear arsenal.
lol. these uneducated responses to the article is hilarious
oh and the "military might" is just on paper. how much do we borrow to maintain that "might"? the 750 basis do not come free you know.... america has become what it fought against in the 18th century. an oppressive empire.
wishful thinking and if anything the Ukraine war has shown to the world that the US cannot be trusted anymore as it uses it's sanctions as a weapon and weaponises the dollar. the days of the dollar are numbered thanks to our brilliant politicians...
korn ftw!
And there are 10 times more reasons to move away from the dollar. Add the number of countries that have a negative view of USA and dementia Joe and it's done
for the reasons you listed in article especially the hegemonic ones are the reason dollar will doom. Sovereign countries are shifting and liquidating bond asset at record pace. after all lesson learned from recent developments related to war
Countries like Russia & China want to topple the USD's reserve currency status so that they have a freer hand to wage wars of aggression to steal others' resources and territories.
Absolute pointless article. Author better start getting some reality dose and rewrite this rubbish.
Pointless article. UK pound sterling is also here to stay but isn't the reserve currency any more.
The PetroDollar is being seriously threatened by the BRICS nations. Meanwhile, the FED is printing money at breakneck speed and fueling inflation. The dollar is nearing its end as the world’s reserve currency. Anyone who says otherwise is either lying to you, or being willfully ignorant.
 Incorrect. The US dollar became the world's reserve currency BECAUSE of the PetroDollar.
  No, the USD became the global reserve currency AFTER de-linking from gold.
 The US dollar wasn't a reserve currency when it was delinked from gold. Read some history.
I hope my kids and grandkids can keep the US dollar alive. With all the chirping from the left about canceling the rule of law, I cringe that that pillar crumbles.
The left? ""REPUBLICANS IN CONGRESS SHOULD DEFUND THE DOJ AND FBI." -- Donald Trump
Tell it like it is, Mike. For all its imperfections, the U.S. and the dollar will continue, as long we manage intelligently.
Typical boomer macro analysis. This nation is in an unmitigated social, economic, and political decline. Socially, look at the total sexual degeneracy that has gone mainstream, the breakdown of the family unit, and the rampant crime in blue cities. Economically, this nation is at 120% Debt to GDP. Everything is built on unsustainable debt. Politically, look rigged elections from 2020 and 2022. Look at the total disregard of the working class by the so called elites. Look at Washington tell lie after lie about the causes and status of Ukraine, meanwhile as Russia, India, China, and Opec and friends are forming trade and currency blocks that exclude the US.
lol China is debt free 🤣 😂
China doesnt want their yuan. Russia doesn’t want ruble. India/China/Russia pertners? Come on.
Wishful thinking 1 cannot take on a unity of many
I have 89 trillion reasons why it will fail in 2029.
which way is the full faith and credit of the U.S. government trending?
A first start is weakening and small of all things.
nice analysis ... just never forget the underdog should not be taken likely... change is inevitable and its going to happen at a faster pace than u could imagine .... goodluck though
dollar here to stay ........for how long?
You can tell Michael and Lance always provide great insights. If I lived in the us, it would seriously consider putting my assets under their management.
getting desperate now
Merci
Nailed it. I’m skeptical of who is behind pushing the narrative of the dollar’s decline so much recently, but it changes nothing. The people regurgitating that disinformation just out themselves as fundamentally lacking a basic understanding of macroeconomics and especially the currency markets. This is the most succint article I’ve seen explaining why the US dollar will be at the top for a long time.
   The DXY has been in an uptrend channel since the GFC; it's currently near the middle of it's 60 year range.
A big reason why countries like Russia & China wants to end the USD's reserve status is so they can go steal other's resources, assets, territories, etc. with less repercussions.  If economic sanctions were ineffective, the US and its allies would have to take more kinetic countermeasures as Russia & China are more emboldened to be more d bag.
And if things get kinetic between the US & China, the US will legitimately cancelled its debts to China unilaterally.
Interesting, if GBP + all European countries joined the Euro, some competition to USD is possible, US cant 'do military' in that case to supporg the USD
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